What is 'Capital Employed'
Capital employed, also known as funds employed, is the total amount of capital used for the acquisition of profits. It is the value of all the assets employed in a business and can be calculated by adding fixed assets to working capital or subtracting current liabilities from total assets. By employing capital, you make an investment.
BREAKING DOWN 'Capital Employed'
Capital employed is a frequently used term but is very difficult to define because there are so many contexts in which it can be used. All definitions generally refer to the investment required for a business to function. It refers to the value of assets used in the operation of a business. Put simply, it is a measure of the value of assets minus current liabilities. Both of these measures can be found on the balance sheet. A current liability is the portion of debt that must be paid back within one year. In this way, capital employed is a more accurate estimate of total assets. Like return on assets, investors use return on capital employed to get an approximation for what their return might be in the future.
Capital employed is primarily used by analysts to determine the return on capital employed. Return on capital employed (ROCE) is thought of as a profitability ratio. It compares net operating profit to capital employed and tells investors how much each dollar of earnings is generated with each dollar of capital employed. Some analysts prefer return on capital employed over return on equity and return on assets since it takes long-term financing into consideration, and is a better gauge for the performance or profitability of the company over a longer period of time. A higher return on capital employed suggests a more efficient company, at least in terms of capital employment. A higher number may also be indicative of a company with a lot of cash on hand since cash is included in total assets. As a result, high levels of cash can sometimes skew this metric.
ROCE Calculation Example
Return on capital employed is calculated by dividing net operating profit, or earnings before interest and taxes, by employed capital. Another way to calculate it is by dividing earnings before interest and taxes by the difference between total assets and current liabilities.
As an example, if a company makes $10,000 in operating profit, has $100,000 in assets and $25,000 in current liabilities, the return on capital employed is $10,000 divided by $75,000, or 13%. A return on capital employed of 13% means that for every dollar invested in capital employed, the company made 13 cents of profits. By contrast, if the company made $50,000 in operating profit, the calculation is $50,000 divided by $75,000, or 60%, which is much better. In the latter example, the company is making five times more money per dollar of capital employed.